Pre-Funding Can Shave Billions off Calif. OPEB Cost

February 24, 2012 (PLANSPONSOR.com) – California State Controller John Chiang released an actuarial report showing the 30-year cost of providing health and dental benefits for state retirees is $62.1 billion.

The unfunded obligation as of June 30, 2011, grew $2.2 billion from the $59.9 billion obligation identified as of June 30 2010. The accrued liability grew less than expected due to favorable healthcare claim experiences linked to a combination of fewer claims, less expensive claims, less utilization of services, and the implementation of new California Public Employees’ Retirement System’s (CalPERS) health programs designed to reduce costs.

California pays for retiree health benefits on a “pay-as-you-go” basis, or the minimum amount needed to fund the costs as they are due. The latest actuarial report estimates California’s obligation for retiree health and dental benefits, also referred to as Other Post-Employment Benefits (OPEB), based on two different funding scenarios:

The current pay-as-you-go policy results in an actuarial unfunded obligation of $62.1 billion, which represents the total the state would need to pay for future retiree health benefits earned as of June 30, 2011, by current and future state retirees. Based on this unfunded obligation, California should pay $4.7 billion in 2011-12 to pay for present and future retiree health benefits. In the 2011-12 Budget Act, the state provided $1.71 billion to only cover current retirees’ health and dental benefits.

If the state shifted to fully pre-funding the costs of future benefits, the actuarial unfunded obligation would be cut by more than $21 billion to $40.7 billion. Under a full pre-funding approach, the state would set aside money in a separate trust solely for future retirement healthcare benefits. The investment income generated by the trust would be used to reduce the costs to the state and its employees of paying for future benefits. To take advantage of the tremendous cost savings resulting from fully-prefunding, the state would need to contribute $3.3 billion in 2011-12, or $1.6 billion more than the state currently pays.

Recognizing that fully funding the health and dental benefits obligation is unlikely given the state’s tight budget, Controller Chiang noted that even incremental steps toward pre-funding the obligation would significantly reduce the state’s liability. For example, if the state pre-funded just 10% of its obligation, it would only need to pay $160 million more than its current pay-as-you-go contribution. However, that additional payment would shave $2.7 billion off of the state’s unfunded liability.

Pre-funding 25% of its obligations would cost the state $400 million more than the pay-as-you-go contribution, but would reduce the total unfunded liability by $6.54 billion.

In 2004, the Governmental Accounting Standards Board Statement 45 (GASB 45) required states and local governments to publicly disclose the future costs of paying for post-employment benefits other than pensions for current state retirees and employees.